The Lockdrop and Liquidity Bootstrap Auction: Still a Good Token Launch Mechanism

One of this paper’s co-authors, Alex Golding, recently spoke at Permissionless about “How to Launch a Token.” During this, he realized that both his co-panelists and the audience were unaware of Delphi Digital’s recently used token launch mechanism, the Lockdrop and Liquidity Bootstrap Auction (LBA). Given that we think it is a very useful tool, we wrote this primer for the community.

The Lockdrop and LBA is a two-phase process that solves most if not all of its predecessors’ issues, as traditional token sales (a) have heightened legal risks; (b) do not allow the public to set the initial trading price; (c) often reward past users via an airdrop that is quickly dumped, resulting in a significant decline in token price; (d) frequently suffer from such a low float that the token price increases dramatically at launch and then slowly bleeds out; and/or (e) often do not have deep liquidity in the initial launch pool.

The Lockdrop and Liquidity Bootstrap Auction method mitigates these problems, and so we hope to see its use proliferate throughout the industry. While this paper serves as a brief primer, an interested party can find in-depth details in our case study on Astroport’s Lockdrop and LBA.

Phase 1: the Lockdrop

The purpose of the Lockdrop is to solicit commitments from the public to be users of and/or liquidity providers to the new protocol for a period of time. In return for promising to be a future user, they are rewarded in the new project’s native token. Contrast this to an airdrop which rewards people for previously being a user but does not incentivize them to use it after the airdrop, and it is obvious that the Lockdrop supports the future of a protocol more than an airdrop does.

To participate, users deposit another project’s tokens (chosen by the founding team) into the protocol and the deposit is locked away for a set amount of time as a sign of the users’ commitment. In return, the depositors receive the new project’s native token as a reward. These can (depending on each users’ preference) later be deposited into the token side of the protocol’s soon-to-be-launched liquidity pool or can be free-claimed (either immediately or with some unlocking schedule). This design encourages liquidity provisioning on the initial AMM, and results in an instant and deep pool of native tokens for the public to trade post-launch.

Phase 2: The Liquidity Bootstrap Auction (LBA)

The LBA is the mechanism that allows the community to set the price of the new token and fill its liquidity pool so that there is immediate breadth and depth to the trading pair. This liquidity pool is filled by getting the participants from Phase 1 (the Lockdrop) to deposit the project’s native token (the rewards received for committing to being a future user of the protocol) into one side of the pool, and by asking the general public to deposit a pre-specified stablecoin into the other side. The exact amount of time users can do this is set by the protocol architects.

The LBA process guarantees a fair price set by the public. How? Well, the price of a token is determined by the formula: quantity of stablecoins/quantity of project token. In other words, if there are $10 worth of USDC and 100 project tokens (sourced from the Lockdrop), the price of the project’s token is $10/100 = $0.10 per token. To ensure that users are not rugged by price volatility and potentially shut out of the LBA, we found that limiting the number of stablecoins that can be withdrawn towards the end of the process, with stablecoin withdrawals being completely disallowed during the last day, will prevent whales from manipulating the price. We believe in limiting price manipulation and think this is a superior design.

Upon completion of the LBA, the token has officially launched, and the community can now trade the new token freely. The general public will find deep liquidity that facilitates trading, while the participants from the Lockdrop will have locked funds earning rewards in exchange for supplying said liquidity.

Conclusion

The Lockdrop and Liquidity Bootstrap Auction solve several issues that traditional token launch mechanisms have. Namely, this two-phase process incentivizes the community to use the protocol in the future, allows the public to set the price, limits the opportunity for price manipulation, eschews a token sale (and thus could be better from a US regulatory perspective), and immediately provides a deep liquidity pool. While it is not appropriate for every protocol, we do believe that it is useful for many and should be considered by every team. With this in mind, if a team decides to use it, we hope they tweet us @Delphi_Digital and let us know about it so we can monitor its progress, offer some project-specific modifications, and happily partake in supporting new projects.